Business

Passive activity regulations create many tests for categorizing income and losses

Article Abstract:

The set of Proposed and Temporary Regulations under Section 469 offer guidelines and tests for distinguishing between personal service, portfolio income, and passive income. Portfolio income, guaranteed and preference returns, most mineral royalties, personal service income, and limited rental income are all taxed as non-passive income. Most rental income and most royalties from licensing intangible property are deemed passive income. Gain from sale of property used in more than one activity in the preceding 12 months must be allocated as passive or non-passive depending on the proportion of previous uses. Deductions must be classified according to type of activity in the tax year. Disposition of interest in an S corporation or partnership will be proportioned to net gain or loss that would have resulted from separate dispositions.

Active participation in activity can avoid the limitations on passive losses

Article Abstract:

New Temporary Regulations establish the levels of participation in a business activity that will permit full deduction of losses. There are seven exclusive tests for meeting the material participation test. Any loss is still a passive loss when an individual's participation is significant but not material. However, any income is excluded from the passive category. Ownership of a working interest in oil and gas property is excluded from the passive activity limitation except in certain cases. The passive activity loss limitation generally applies to C corporations that are 'personal service corporations', and to some closely held corporations. The passive activity loss of the taxpayer is disallowed. The limitation of taxpayer's credits from passive activities is similar to the limitation on allowance of passive activity losses.

Proposed regulations ease determination of activity for PAL rules

Article Abstract:

New regulations governing the limitation on passive activity losses (PAL) and credits have been issued by the IRS. The rules include a facts-and-circumstances method of determining taxpayer activities which the Service recommends as a replacement for the currently applied mechanical rules. Application of the PAL regulations may be applied for tax years ending after May 10, 1992. It is, therefore, advisable for tax planners to start considering which is more advantageous when losses are currently limited or when there is a possibility that deduction of suspended losses may be allowed. The two approaches to determining taxpayer activities are compared.